Proposed Regulations for Captive Risk Retention Groups

September 11, 2006

The Risk Retention Group Task Force (“Task Force”) was created by the National Association of Insurance Commissioners (“NAIC”) to determine a set of nationwide standards to which captive Risk Retention Groups (“RRGs”) should be held.  The Task Force is in the process of considering which standards from the NAIC’s existing Part A Accreditation Standards for traditional insurance companies it will require captive RRGs to follow.  Captive RRGs are currently afforded a great deal of flexibility because they are exempt from the Part A standards for accreditation.  Further, at this time there is no nationwide, uniform regulation of captive RRGs like there is for traditional insurance companies.  The Liability Risk Retention Act of 1986 requires a captive RRG to adhere only to the regulations of the chartering state, and the non-chartering states have very limited authority over the captive RRG.  However, when the NAIC adopts the recommendations by the Task Force, states accredited by the NAIC will be required to accept the standards for RRGs that are currently being determined by the Task Force.

As the Task Force continues to wade through the NAIC Part A Accreditation Standards, important decisions are being made that will affect captive RRGs nationwide.  There is concern among captive RRGs that the uniform requirements of the NAIC Part A standards will be inappropriate for RRGs.  The following is an update on the determinations made by the Task Force in its most recent meetings of May 4, May 19 and June 10, 2006, when the Task Force addressed the applicability of Standards 1, 3, 4, 6, 7 and 12. 

Part A, Standard Number 1 - Examination Authority:  Element (f) requires state insurance examiners to observe the guidelines and procedures set forth in the NAIC Financial Condition Examiners Handbook.  These guidelines and procedures are generally applicable to captive RRGs.  However, certain elements are not applicable.  A state may need to perform procedures in addition to those in the Financial Condition Examiners Handbook for RRG-specific or GAAP-specific items (e.g., deferred acquisition costs, reserve discounting, etc.).  Inapplicable and additional procedures will be included in the Task Force’s final recommendation to the NAIC.

Part A, Standard Number 3 - NAIC Accounting Practices and Procedures:  Management’s Discussion and Analysis for captive RRGs should be filed April 1, following the March 1 filing of the annual statement, in accordance with the NAIC Annual Statement Instructions.  The NAIC Annual Statement Instructions for actuarial opinion filings should apply to captive RRGs and any actuarial opinion should address all business and potential claims applicable to RRGs, including those under contractual liability business.

Part A, Standard Number 4 - Corrective Action:  State commissioners must identify standards to determine whether the continued operation of any captive RRG might be hazardous to the policyholders or the general public.  The state commissioners must have the authority to issue an order requiring the captive RRG to take action when determined hazardous and the insurer should have the ability to request a hearing to review any order issued. 

Part A, Standard Number 6 - Holding Company Systems:  Element (b) is applicable to captive RRGs, requiring insurer’s investments be limited to the lesser of 10% of the insurer’s assets or 50% of the insurer’s surplus as regards policyholders, except in instances where a greater investment has been approved by the state commissioner.  

Part A, Standard Number 7 - Risk Limitation:  The issue is whether or not there should be a 10% risk limitation applied to each state’s captive RRGs, whereby the net amount of risk retained for an individual risk could not exceed 10% of a captive RRG’s insurer’s capital and surplus.  There was disagreement among the members of the Task Force on the applicability of this standard to captive RRGs.  Vermont was against this standard being applicable to RRGs because captives are much more micromanaged and they are regulated differently from traditional companies.  Vermont felt that the standard is not necessary for captive RRGs because the domiciliary regulators know a lot about the companies and what they are writing in his/her respective state.  South Carolina disagreed, stating that South Carolina requires a company to move toward the 10% limit over time, and although it may not necessarily be appropriate to apply the 10% standard to captive RRGs, there needs to be some sort of similar measure.  Nevada has a five-member hospital captive RRG that is not going to grow over time because that is not their purpose for being a business, and therefore this limitation would not be applicable to them.  Nevada agreed with Vermont ’s comments that the standard is unnecessary because captive RRGs are closely regulated within their domiciliary state.  In Vermont , the regulators run the ratio periodically and for those captive RRGs that exceed the 10% risk limitation, there is always a reason why.  Vermont regulators did not feel that applying a risk limitation on RRGs would work in the state of Vermont .  Arizona noted that its approach is similar to South Carolina ’s.  Further discussion, and any subsequent decision, was tabled until the next meeting of the Task Force.

Part A, Standard Number 12 - Require Opinion by Qualified Actuary or Specialist:  This standard is applicable to captive RRGs.  Current standards for accreditation simply state that an actuarial opinion should be required but they do not discuss the form or content of the opinion. 

Frost Brown Todd currently represents several captive RRGs in Indiana, Kentucky and Tennessee.  As the Task Force continues to propagate increased standards of regulation for captive RRGs, we will keep you up to date on the status of the proposed regulations.  Should you have any questions or would like additional information concerning the formation or regulation of captive RRGs or other forms of alternative risk transfer, please feel free to contact Greg E. Mitchell at 859-244-7548 or gmitchell@fbtlaw.com or other members of the FBT Insurance Industry Group.

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